UPDATE 1-Mandelson says British banks overreact to crisis

(Adds Mandelson quotes on plan for struggling businesses)

LONDON, Nov 29 (Reuters) - British Business Secretary Peter Mandelson accused banks on Saturday of overreacting to a liquidity crisis and said they had now become too conservative with their lending policies.

He said banks risked further damage to their balance sheets and profits by not providing cash to small businesses. There was a "disjunction" between what he was hearing from firms around the country and bankers in London.

"The banks have experienced a sharp liquidity crisis. They have lent too much at too cheap a price for too long. But they are now overreacting to that, in my opinion, in too conservative and restrictive a way," he told the Guardian newspaper.

"They are in danger of substituting one set of problems for another, and in the process doing themselves further damage by underlending and not strengthening their balance sheets and profits in the longer term. They are close to cutting off their noses to spite their faces."

Mandelson, a surprise recall to Prime Minister Gordon Brown's government this year, said he did not know how long the recession would last, appearing to contradict official government forecasts last week that the British economy would move out of recession in the second half of 2009.

"No one can foretell how short or long, how painful or painless, the recession is going to be.

"The recession will determine our borrowing our taxing and spending. All I know is that the deeper we get into the recession, the higher the costs of climbing out will be," he said.

His comments come as the latest ICM opinion poll showed Brown had slipped further behind opposition Conservatives, with the gap widening to 15 points, suggesting voters have doubts about the government's tax-cutting and borrowing plans to ease the pain of the economic downturn.

The poll placed the Conservatives on 45 percent, a jump of three percentage points, compared to just 30 percent for Labour.

The government announced plans on Monday for a 20 billion pound ($30.86 billion) stimulus package to support the flagging economy that include a temporary cut in Value Added Tax to 15 percent and a new 45 percent tax band for higher earners.

Mandelson also said he was looking at a draft plan to identify sectors of British businesses that may need government help if the recession deepens.

He said he believed industry wanted more activism from the government. This week major retail chains Woolworths group PLC WLW.L and furniture chain MFI went into administration as British retail sales plunged in November at their fastest pace since records began 25 years ago.

"They don't want us to pick winners, but they do want a route map," he said.

However, he told a conference of the centre-left Progress think tank that the government would not embark on "futile" bailouts.

"The one thing we are not going to do is to embark on a rather futile journey to bail out every company in trouble, to prop up companies that aren't viable or frankly to extend the life of companies or businesses that are not any more competitive," the Press Association reported.

"That is not the job of government.

"What we do need to do is to look at how companies and sectors of industry which are, and will continue to make a very, very important contribution to our manufacturing and industrial wealth producing future, to see what the appropriate role of government would be in helping them through the current recession so that they can take advantage of the upturn on the other side."

"We are at the beginning of a preliminary conversation about that; I do not have a blueprint or a list of companies or sectors that we are suddenly going to intervene in." (Reporting by Frank Prenesti; editing by Michael Roddy)